South Korea increases scrutiny on crypto exchanges with FSS inspections

South Korean regulators are ramping up their oversight of cryptocurrency exchanges as part of a broader effort to combat illicit activities in the crypto space.

With the rise in scams and fraud, the Financial Supervisory Service (FSS), under the Financial Services Commission (FSC), is preparing to inspect on-chain transactions, marking a significant step in the country’s regulatory approach.

According to local media, this inspection will focus on two of the four Korean won-based exchanges flagged during initial reviews for “unusual activities.”

This upcoming scrutiny, the first of its kind, falls under the Virtual Asset User Protection Act (VAUPA), enacted in late July, which aims to enhance consumer protection and enforce stricter regulations in the cryptocurrency sector.

South Korea’s stringent rules for crypto exchanges

The new regulations categorize cryptocurrency exchanges as Virtual Asset Service Providers (VASPs), imposing several stringent requirements to ensure customer protection.

These rules were introduced in response to high-profile incidents like the Terra Luna collapse and the FTX scandal, which exposed significant vulnerabilities within the crypto industry.

One of the key mandates requires VASPs to hold at least 80% of users’ assets in cold storage, ensuring they are kept secure from potential cyber threats.

Additionally, these assets must be insured, segregated from company funds, and invested in risk-free, yield-bearing products with credible financial institutions designated by the FSC.

This framework is designed to minimize risks and protect users’ investments.

Further, VASPs are required to maintain transaction records for a minimum of 15 years to ensure traceability and transparency.

They must also promptly report any suspicious or abnormal activities to the authorities, reinforcing the government’s efforts to prevent money laundering and other illegal activities within the crypto space.

Key details of the FSS inspections

The FSS inspection, the first under the new regulatory framework, is funded by a supervisory fee that VASPs must pay based on their operating revenue.

These inspections will primarily target illicit or suspicious transactions and verify compliance with the mandates established under the VAUPA.

The FSS has made it clear that failure to comply with these regulations, or any involvement in illegal activities, will result in “stern punishment.”

Individuals found guilty of amassing more than 5 billion won (approximately $3.7 million) through illicit crypto-related activities could face life imprisonment, underscoring the severity of the government’s crackdown on financial crimes in the crypto sector.

Beyond the initial two exchanges under scrutiny, the FSS may extend inspections to other entities, including three additional crypto exchanges and a wallet provider, should any complaints arise.

These rules also apply to all other approved entities operating within South Korea’s crypto market.

The regulatory focus in South Korea isn’t limited to exchanges alone.

Cryptocurrencies traded on South Korean platforms are subject to periodic reviews as part of a best-practice plan for supporting virtual asset transactions.

Although these guidelines are not directly part of the VAUPA, they are additional rules established by industry groups like the Digital Asset Exchange Alliance (DAXA) and enforced by South Korea’s financial regulators.

These measures reflect South Korea’s commitment to maintaining a secure and transparent cryptocurrency market while protecting consumers and mitigating the risks associated with digital assets.

As the regulatory landscape continues to evolve, South Korean crypto exchanges and related entities will need to navigate these stringent requirements to remain compliant and avoid severe penalties.

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